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Gambling vs Trading

I was thinking about this earlier and so I thought I'd write down my thoughts.

In any game or business where the outcome of an event is uncertain you can consider that to be a gamble of sorts. The word gamble has a negative conotation and is often associated with high risk and low probability of return.

Taken in this context, you can consider that any 1 trade that you place will be a gamble if the net expected return is less than or equal to 50%. The net expected return should include the pro-rata cost of doing the trade i.e. commissions, equipment and trading services.

If your net expected return is over 50% then you should, in the long run, come out ahead of the game using the law of large numbers.

Some types of gambling are exactly that: gambling. Roulette for example is always gambling. The expected return on any single spin of the wheel is always lower than 50%.

Poker and Blackjack have varying expected returns and at some points during these games your expected return on any one event will be greater than 50% and so these games allow for both gambling and trading.

Buying a lottery ticket is a gamble. There is always a less than 50% expected return from that event.

We could go on and say that everything that you do in life is a gamble but then we start becoming philisophical and that's not going to help us trade.

So how can we turn a trading gamble into an expected profit?

Discipline and routine!

Each time, before you execute a trade, ask yourself if you know what the expected outcome of a trade under these conditions will give you. Sometimes you only have 30 seconds to ask yourself this question. If you find this happening often then try and anticipate the signals that are about to be generated by your system and ask yourself how often this has happened before and what happened on the times that you tried this.

Say that you got stopped out 4 times in a row. Is this a gamble? That depends on what you're risking for what return and how often you get your return. Say, you get stopped out 4 times for each 2 winners. This means that you have a 33% win rate. You might not think that is a great trade and is in fact a gamble but if you then discover that you win 6 points when you win and lose 1 point when you lose then you discover that you make 12 poitns for every 4 points lost. It is then apparent that that particular style of trading is not gambling.